Are Irish businesses about to encounter a ‘perfect storm’?
Faced with a myriad of increasing challenges, effective working capital management over the coming months will be key for business survival. Declan Taite, Managing Director at Kroll in Ireland, looks at the impact of the mounting pressures on businesses, the need for a proactive approach and some of the restructuring options available.
The economic and trading landscape has fundamentally changed for Irish businesses over the past 12 months. The enthusiasm demonstrated by consumers, following the return to a more normalised society after two years of Covid pandemic curtailments and restrictions, is now rapidly being replaced with a genuine cautiousness and concern. What will the resultant impact of consumer sentiment have on businesses as we enter the final three months of 2022?
Irish businesses are facing into a period of huge uncertainty. Now more than ever, ‘cash is king’. Managing the working capital cycle and stringent cash management is now the absolute primary focus of the majority of businesses, particularly those in the Small and Medium Enterprises sector. There is an alarming, almost unprecedented, increase in the number of issues currently affecting Irish businesses. Government Covid-related supports have now been withdrawn for several months. 105,000 Irish businesses availed of the Revenue Commissioners Warehoused Debt Scheme with liabilities exceeding c.€3bn, and these liabilities will have to be repaid, starting in early 2023.
Energy cost inflation is starting to impact businesses and this will only worsen as we enter the autumn/winter period. The most recent interest rate increase of 0.75% imposed by the European Central Bank will affect existing business loan repayments. This is on top of the 0.50% increase announced in July 2022. Borrowing has become less attractive and affordable.
Supply chain issues, costs of supplies, availability of labour and associated wage pressures are further compounding an already growing list of challenges for businesses. However, the biggest impact is likely to come from a decline in discretionary spend by consumers due to cost-of-living increases. The short-term outlook looks concerning at best for a significant number of businesses.
RELENTLESS FOCUS ON CASH FLOW
Cash flow is the lifeblood of all businesses, particularly SMEs. Effectively managing the various component parts of a business’s cash flow could be the difference between business survival and failure during periods of uncertainty and volatility. One of the key essentials to managing cash flow is having timely, reliable financial information upon which key decisions can be based.
It is crucial to prepare and regularly update cash flows,
ideally on a weekly basis. This will greatly assist in identifying issues sooner and allow precipitive action to be taken. Cash flow forecasting should be conservative, particularly in quantifying cash inflows from sales, and should be supported by a rationale and assumptions. Incorporating contingencies for unexpected sales decline or cost increases is also prudent management. Critical assessment of aged debtors, stock management, labour costs, aged creditors, should be undertaken and rigorously monitored.
How effective are businesses at managing cash outflows and unnecessary expenditure? Identifying cash flow deficiencies and funding requirements early is imperative. The source and cost of funding requirements is also key. With increasing cash flow pressures, businesses need to be conscious of not taking on unprofitable contracts and merely carrying out work and providing supply or service for cash flow purposes. Whilst it may have some benefit in the short term, it will have detrimental implications in the medium to long term.
‘The next number of months will undoubtedly be challenging for all businesses’
FORMAL RESTRUCTURING OPTIONS
Unfortunately, despite the best efforts of owners and management, some businesses may require to right size or restructure through a formal process, such as examinership or the Small Company Administrative Rescue Process (SCARP), to implement the fundamental requirements for business survival. The appropriate process will very much depend on the individual company circumstances.
Irish businesses have traditionally used examinership as a formal restructuring process to facilitate business rescue. The process provides court protection from creditors, for a maximum period of 100 days (currently extended to 150 days) to a company while the examiner seeks to restructure the business and implement a scheme of arrangement where creditors must obtain at least what they would obtain if the company was wound up or placed in liquidation.
The recently introduced European Union (Preventive Restructuring) Regulations 2022 has brought about a number of notable amendments on how the examinership process operates. One of the more significant amendments relates to the minimum voting requirements to approve a scheme of arrangement. It is now a requirement that at least one class of creditor must be ‘in-the-money’.
In other words, if the company were to be liquidated, the class of creditor who has voted in favour of the scheme must be in line to receive some form of dividend payment as part of the liquidation process. This is a material departure from how examinership previously operated. The regulations also introduce a ‘Best Interest of Creditors Test’. At a practical level, a court cannot now sanction an examiner’s scheme of arrangement if it is satisfied the proposals do not satisfy this test.
The examinership process is intensive, is not suited to all companies, and the best outcomes are achieved when pre-planning is maximised. Examinerships can be a relatively costly exercise and should only be entered into with a clear picture of the likely outcome rather than as a last-resort exercise. It will be interesting to observe how these legislative changes impact the use of examinerships over the coming months.
THE SMALL COMPANY ADMINISTRATIVE RESCUE PROCESS
SCARP is a formal restructuring process that came into effect in December 2021. It is specifically targeted at SMEs) and allows companies to restructure their balance sheet in a timely and cost-efficient manner. The SCARP initiative is modelled on examinership, which is often cost prohibitive for many SMEs, and is structured and designed to reduce court oversight, and subject to certain conditions, avoid applications to the courts. The process can be concluded within a shorter period than examinership which can run for up to 150 days, while SCARP seeks to implement a rescue plan within 70 days.
The process is available to SME companies unable, or likely to be unable, to pay their debts as they fall due. To qualify, companies must meet two of three criteria, in relation to the previous two financial years. They must have had an annual turnover of up to €12m, balance sheet total of up to €6m, or up to 50 employees.
SCARP is not a panacea to resolve a company’s financial difficulties. However, it does afford viable companies a framework to be restructured and provides a workable alternative to examinership. SCARP is a potential lifeline to many SMEs, which now have access to a workable and pragmatic restructuring process, thus potentially avoiding a liquidation scenario which would undoubtedly result in a less favourable outcome for all parties concerned. While not all businesses will be suitable for SCARP, the process can result in a more seamless, efficient, and ultimately successful outcome for SME businesses in need of restructuring.
The next number of months will undoubtedly be challenging for all businesses, with huge uncertainty and strong headwinds. Proactive and effective working capital management will be key for business survival and will increase the options available for distressed businesses.